Internet Sales Tax: Here Come the Auditors

Internet sales tax legislation could subject small online businesses to up to 46 state audits.

And since sales taxes vary among thousands of tax jurisdictions across the country, the chances that auditors will find mistakes—and slap the business owners with penalties—are very good. If truth-in-advertising requirements applied to legislation, says Heritage Action’s Dan Holler, the Marketplace Fairness Act would be renamed the Tax Audits from Hell Act of 2013.

Here’s how the bill works: Online businesses would be required to figure the sales tax each customer owes based on where the customer lives—even though the businesses themselves have no other dealings with that state or local government.

There are more than 9,600 state and local taxing jurisdictions in the U.S., and small businesses would be required to send the appropriate number of tax dollars—state and local—to every one where they sell.

And if the business owner makes a mistake? Or if the state thinks that the business owner makes a mistake? The bill provides for “a single audit of a remote seller for all State and local taxing jurisdictions within that State.”

This provision is intended to streamline the process, but it still means every business could face 46 separate audits (from the 45 states that collect sales taxes plus the District of Columbia).

Audits cost businesses time and resources that could be used to create jobs, develop and market new products, and bolster the economy. To be audited in distant locations where they have no presence other than a few customers makes that burden even greater.

And while computer programs might help them calculate the sales tax they are supposed to collect for each transaction, they still need to send that money to the appropriate place.

As Megan McArdle asks at The Daily Beast, what happens after business collect the appropriate sales taxes? “Do the sales tax fairies simply whisk it off to the nice folks at the state tax department? Sadly, no.” The Small Business Administration explains the process of filing a tax return this way:

Generally, states require businesses to pay the sales taxes they collect quarterly or monthly. You’ll have to use a special tax return for sales taxes, and report all sales, taxable sales, exempt sales and amount of tax due. Not paying on time can result in penalties. As always, check with your state or local government about the process in your location.

This would be a bureaucratic nightmare. Sarah Parness writes for ABC News:

[F]ive states do not have state-wide sales tax, but two of those states—Montana and Alaska—allow localities to charge a sales tax. So a business owner in New Hampshire—which has no sales tax—sending a fishing pole to a customer in Juneau, Alaska, would have to collect a 5 percent sales tax, but would charge no sales tax to the buyer in Denali Borough.

Small businesses, like Wayne Johnson’s Idaho-based online fly fishing shop Angler’s Habit, or Todd Dickie’s Nebraska-based online ATV parts company Powersports Nation, will have to send money to up to 46 states regularly or endure swarms of audits and penalties.

“[I]t’s going to be hell on sole proprietorships and other small businesses that can’t afford the compliance overhead,” writes McArdle. “Anyone who has had to file income tax returns in two states can imagine why you might not want to file in almost 50—monthly.”

Lawmakers should be finding ways to reduce burdens on consumers and entrepreneurs. Instead, this bill would impose new costs on both.

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